China Employee Terminations in These Tough Times

Even in the best of times, employee terminations in China are fraught with risk. A mishandled China employee termination (or even just the discussions surrounding the termination) can quickly cause problems. China’s declining economy has weakened its job market and made both employees and the government more likely to fight back against any little termination mistake.

Now is not a good time for employers in China (especially American companies) to be doing anything that does not fully comply with China’s employment laws. China’s relations with the West — especially the United States) are at a low point right now and this has and will continue to play out to the detriment of every Western company doing business in China. See China Retaliation Is “11” on Scale of 1 to 10, in which Bloomberg News highlights “increased anecdotal evidence that the Chinese government is tightening its overview of foreign firms.” This has already translated into China significantly toughening its law enforcement against foreign businesses, including on the employment law front.

All this means that employers in China need to have well-crafted employment contracts and employer rules and regulations (aka employee handbook) and should also periodically conduct employer audits to make sure their China employment program (in each city in which they have an employee) is in good legal shape.

It is critical that you perfectly map out and execute your China employee terminations. Better to be deliberate and correct than to act in haste and get even the smallest aspect of your employee termination wrong. You are far more likely to lose than save money by getting rid of an employee quickly.

For example, before you tell an employee that you will be terminating her or him you should first consider this fundamental question: What is the basis for the termination? In turn, the basis for the termination will determine the path you should take. Will the termination be a unilateral termination with a legally permissible basis or should you seek instead to settle with the employee and have the termination be a mutual termination? Your answer will determine how much severance you are required to pay (if any), which is a super-important issue in China. There are other important issues that nearly always come up with China employee terminations, such as bonus, overtime pay, compensation for unused vacation days, reimbursement for work-related expenses and non-compete provisions. Ideally, you should consider each one of these before you even approach an employee regarding termination. At the very minimum, you should not initiate an employee termination until you have determined the basis for the termination and the severance amount you will need to pay.

Consider this by-now-common scenario. A U.S. company is going through structural changes in multiple office locations in the U.S. and is considering laying off employees in its China office as well. Without China-centric termination agreements and without checking with the local labor authorities, the HR head at U.S. headquarters informs China employees of the company’s termination decisions but does not inform them of how much severance they will get. The terminated employees then file a labor claim. By not being prepared, the employer has made things much worse. If the employer had worked out mutual terminations with its terminated employees and secured signed mutual termination agreements with each of them, it likely could have avoided employee lawsuits and government hot water. If it had not been feasible for this company to negotiate a mutual termination deal with every terminated employee, it still likely could have avoided (or at least reduced) its legal difficulties by first consulting with its local labor authorities regarding a mass layoff.

Here’s another example. A foreign company believes one of its employees engaged in an illegal activity. Without first checking its China employer rules and regulations and the employee’s employment contract and without making sure it has preserved tangible evidence supporting its belief that the employee engaged in illegal activity, the company unilaterally terminates the employee with no severance on the day it discovers the alleged misconduct. The employee will likely sue the employer claiming wrongful termination and it likely will win. No matter the eventual result of the lawsuit, it will likely be expensive and time-consuming. When our China employment lawyers are confronted with situations like this, we usually start by determining whether the employee’s conduct (and the circumstances) warrant a unilateral termination under Chinese law. In many cases, it does not. If the employer is not legally entitled to a unilateral termination, what usually (but not always) makes sense is a mutual termination. However, in some cases, even if a unilateral termination comes with risks (as it virtually always does), it may be the employer’s best option. Whether or not our client goes ahead with a unilateral termination, our goal is to provide our client with enough information so it can know its risks and can make a thoughtful cost-benefit decision on how to proceed.

Foreign employers in China tend to want to move quickly when terminating a non-performing or problem employee before the employee’s probation period has ended. However, in most of these cases, the probationary employee does not come within any particular grounds for termination under Chinese law that would allow the employer to unilaterally terminate. In these cases, the employer’s best option is usually to pay the employee severance in exchange for the employee voluntarily leaving (i.e., a mutual termination). And since this termination will be structured as a mutual termination, whether or not the termination occurs within the probation period is not important.

With these leaner times in China and elsewhere, we have recently been seeing foreign companies terminating one or more of their employees and then “hiring” them back as “consultants”. This is almost always fraught with problems. Before doing something like this, you should first answer why you want to terminate this person in the first place and why you want to “hire” her back as a consultant. Most importantly, you should be aware that China generally does not allow for independent contractors. Is there an alternative to terminating this employee? For example, when does her contract expire? Can you simply not renew her contract? If you do terminate this employee, is it really worth the risk to then bring her back as an independent contractor? Most importantly, might you not be better off just keeping this person as an employee, rather than taking the double risk of terminating her and then using her as an independent contractor? We have seen situations in which the terminated employee eventually sues the employer both for the initial wrongful termination and for additional pay and benefits from the “independent contractor” stint. The employee alleges (almost always with a good basis to do so) that its consultant relationship should be deemed an employment relationship and seeks damages arising from the employer’s failure to treat her as an employee all along. These make for extremely messy and usually very expensive lawsuits.

One of the most common questions our China employment lawyers get, both from current and potential clients is the following:

We have an employee on a fixed-term employment contract expiring in a month. We can simply not renew the employee’s contract when it ends, right?

Well, it’s not that simple or easy. Let me tell you why.

Consider this hypothetical. Employee and Employer have entered into five consecutive fixed-term employment contracts. Upon the expiration of the fifth term, Employee sends a notice to Employer of her intent to renew and Employer confirms receipt of that notice. Employer then decides not to renew her contract. The relevant law provides that an employee is entitled to an open-term contract after two consecutive fixed-term contracts unless the employer has a legal basis for termination. Employee brings a labor arbitration claim demanding damages for the alleged wrongful termination due to Employer’s failure to execute an open-term employment contract with her upon the expiration of her fixed-term contract. Will Employee prevail on this claim?

In a recent case with very similar facts, the employer lost big time at all levels: labor arbitration, trial, appeal and reconsideration. At the final stage, Beijing High People’s Court ruled that Employer’s decision to terminate the employment relationship constituted wrongful termination and ordered Employer to pay Employee double statutory severance as damages. The court’s reasoning is quite simple: it cited the applicable Article 14 of the PRC Employment Contract Law (which deals with the circumstances under which an employee is legally entitled to an open-term contract). It noted that as Employee informed Employer that she wanted to renew the contract before the end of the-then current term, Employer should have renewed her contract and by failing to renew here contract, Employer violated the law. Employer tried arguing that there were other reasons that led to the non-renewal, including Employee’s poor performance, the difficulties in Employer’s business operation, and job redundancy, but the court rejected all of these arguments.

You as the employer need to know when you are legally required to use a non-fixed term (aka open-term) contract. Our general advice is that as long as an employee meets the applicable legal conditions for an open-term contract and the employer wants to retain the employee, the employer will usually be better off just proposing to renew on an open-term basis. It almost always makes sense to “err” on the side of using an open-term contract no matter how “appealing” the fixed-term approach may seem. Remember that you can still terminate an open-term employee for cause. Though you may proceed with signing a fixed-term contract if your employee explicitly requests this, you need to make sure you document the employee request in a clear writing. Note also that many localities do not permit this even if your employee has requested it.

Second, if you want to terminate an employee entitled to an open-term contract, you must be able to show cause for the termination. For example, if the employer in the above case had hard evidence, proving that its employee had committed a material breach of the employer’s rules and regulations, the employer could have not renewed the employee’s contract without having to pay severance. This though is usually very tough to prove.

This is very different from the renewal/non-renewal at the end of the first contract term. Generally speaking, before the end of an initial fixed term, the employer can simply provide a non-renewal notice to the employee without any explanation for its non-renewal decision so long as it pays the employee statutory severance. But this is pretty much the only time when an employer can terminate an employee for “no reason” at all. Renewals down the road are more complicated. When there is no strong basis for a unilateral termination (which is often the case), it usually makes sense to settle with the employee via a mutual termination agreement. Paying a generous severance usually beats undergoing multiple lengthy, costly, and risky proceedings like the employer did in the above case.

In practice, some employers “force” the employee to agree to a contract for a short fixed-term (usually one year or less), no matter how many consecutive fixed-term contracts the parties have signed, and no matter what the employee requests. This arguably abuses fixed-term contracts in an attempt to avoid using open-term contracts and if an employer gets caught doing this (and they usually do), there will be consequences.

I should also note that we are still seeing local differences in court decisions on this sort of issue, so you (as always) need to act according to your own local requirements. That being said, Beijing, like many other cities in China, remains very pro-employee. So you need to keep that in mind as well.

Proceeding with prudence with any China employee termination will help you prevent legal and government problems and avoid HR hassles. Take  the  time necessary to ensure you have fully resolved all outstanding issues with the relevant employee to the extent you can and make sure you can check all of the “termination boxes” required by China’s local and national employment laws.

The bottom line is that you need to handle all your China employee terminations with extreme care.